The Financial Conduct Authority (FCA) has issued a warning to fund managers to comply with their liquidity management responsibilities, ahead of new rules coming into force for non-UCITS retail schemes (NURS).
The regulator wrote this week (4-page / 162KB PDF) to the chairs of authorised fund management firms to remind them of their regulatory responsibilities. These include suitable portfolio composition, effective fund governance, understanding the investor base and investors' redemption rights and the appropriate use of liquidity tools, particularly in times of market liquidity and stress.
New disclosure, risk warning and oversight requirements for certain NURS will come into force in September 2020, along with mandated temporary suspension of dealing in NURS which invest in inherently illiquid assets where there is "material uncertainty" about the value of more than 20% of the fund's assets. In its letter, the FCA encouraged fund managers and depositaries to consider early adoption of some of the new rules where this was "in investors' interests".
Elizabeth Budd
Partner
Past experience in other areas shows that when the FCA issues a letter such as this, they will have little sympathy for those who do not follow their recommendations.
The FCA also emphasised that effective liquidity management "is an irreducible, core function for all open-ended funds", not just those NURS which will be caught by the new rules.
Investment funds expert Elizabeth Budd of Pinsent Masons, the law firm behind Out-Law, said that the FCA's letter was timely, coming shortly after the announcement that the LF Woodford Equity Income Fund would be wound up. Dealing in the fund, which as a UCITS fund would not be covered by the new rules, was suspended in June over liquidity issues.
"Whilst the ins and outs of what went wrong at the LF Woodford Equity Income Fund will be debated for some time to come this communication from the FCA makes it clear that all fund managers of authorised funds, whether UCITS or NURS, need to take positive action to review their asset holdings and test the liquidity of those stocks," Budd said.
"The FCA has said on a number of occasions now that fund managers must test liquidity. Past experience in other areas shows that when the FCA issues a letter such as this, they will have little sympathy for those who do not follow their recommendations," she said.
Funds which hold assets which cannot easily be converted into cash, such as property, can encounter liquidity difficulties if significant numbers of investors try to withdraw their money simultaneously at short notice. The issue can be particularly problematic where funds are traded daily, as is the case for the majority of the UK retail investment market.
In its September policy statement, the FCA announced the creation of a new category of NURS 'funds investing inherently illiquid assets' (FIIA) from next year. NURS categorised as FIIAs will be required to produce liquidity risk contingency plans, and to provide their investors with "clear and prominent" information on liquidity risks and the circumstances in which they may be prevented from redeeming their investments at short notice. UCITS are regulated at EU level, and are already subject to liquidity requirements.
In its letter, the FCA directed fund managers to its good practice guidance on liquidity management, as well as the 2018 recommendations on liquidity risk management (31-page / 363KB PDF) from global watchdog the International Organisation of Securities Commissions (IOSCO). Both the guidance and the recommendations encourage regular assessment of liquidity demands, effective risk management processes and 'stress testing' to assess the impact of extreme but plausible scenarios on the liquidity of the fund.
The FCA has also encouraged funds to put in place formal liquidity thresholds and 'triggers' which prompt escalation to an appropriate risk committee, or even suspension of dealing in the most extreme cases.
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